Smart Answers

Why Small Business Can't Get Financing

Associate finance professor John Paglia is senior researcher for the Pepperdine Private Capital Markets Project, a twice-yearly survey of privately owned businesses and the lenders and investors who fund them. Its latest report shows that multiple efforts to shake loose capital over the past 18 months are not working, Paglia says, and Main Street continues to suffer. He spoke recently with Smart Answers columnist Karen E. Klein; edited excerpts of their conversation follow.

Karen E. Klein: What groups are surveyed in your study?

John Paglia: We survey banks, asset-based lenders, mezzanine funds, private equity groups, venture capital organizations, angel investors, business owners, business appraisers, and factors. We started the survey in 2009, and it's semi-annual. It's available complimentary to the public.

You surveyed 559 private companies, nearly half of which reported $3 million or less in annual revenue. What are their top concerns?

The No. 1 concern for private companies is access to capital. Nearly 31 percent cited that, even more than the 27 percent that said the economy is their top concern.

What's interesting is that more than half—53 percent—reported that their revenue had increased in the past six months, and 70 percent said their expenses had either declined or stayed the same as a percentage of revenue.

The companies also reported, by 71 percent, that if they had additional growth capital they believed they would see an increase in revenue growth. And 63 percent said they believe opportunities for growth have increased in the past six months.

Your survey shows that banks are more risk-averse than they used to be and they're relying more on collateral and personal guarantees.

It seems that bankers are spending more time reviewing applications than they did in the past. Two or three years ago things were quite frothy, and everyone was a little bit lazy. But now they are really scrutinizing those applications, probably in the manner they should have been doing all along.

Many bankers say they aren't lending, at least in part, because demand for loans is down. But your survey seems to contradict that assertion.

Generally speaking, we found more demand for loans among business owners. And among the banks that responded to our survey, 72 percent indicated that the number of loan applications they received had increased during the last six months. So there's demand for capital. Something's not quite sitting right when we hear from the banks that there's no demand.

What about loan approval rates?

The banks reported that they declined 72 percent of cash flow-based loans, 90 percent of real estate-based loans, and 46.7 percent of collateral-based loans. The quality of cash flow and earnings were cited as the top two reasons that loans were declined, followed by weakening industries and current debt loads.

But your survey shows that the creditworthiness of borrowers has been going up, despite the economy.

Yes. The majority—55 percent—of bankers said the credit quality of potential borrowers has increased in the past six months. That may reflect the fact that the banks are risk-averse, and companies know that they're really ratcheting up their standards. Almost 39 percent said they had tightened up their loan agreements' financial covenants.

You also polled venture capital firms and angel investors, who are often a source of early investment for entrepreneurs. What did you find?

Those capital sources are also becoming more risk-averse because of the hits they've taken recently. The survey shows that they are investing in later-stage companies and in companies in which they have deployed capital already. More than half—54 percent—of angels said they had funded fewer businesses in the past six months.

More than 80 percent of angel investors predicted that the demand for funding will increase in the next 12 months, but nearly 80 percent also said that investment restrictions will increase or stay the same during that period. And 57 percent said the general appetite for risk has declined.

What does that kind of cautionary attitude mean for the economy at large?

It's a troubling trend. It means there's a dearth of capital opportunities for the upstart businesses that potentially—down the road—could lead us to economic prosperity.